Omar Khan: What is Financial Inclusion?

September 24th, 2013

What is financial inclusion and why is it an important issue for immigrants? In our new report Good Ideas on Economic Inclusion: Access to Banking, Omar Khan, Runnymede Trust, U.K., offers expert commentary and context for a selection of good practices that illustrate some of the multiple and overlapping strategies being developed by innovative city leaders, civil servants, business and community organizations in cities across Canada, the U.S. and Europe.

Across cultures, ancient parables explain the importance of saving when times are good and borrowing when times are bad to minimize our individual and collective suffering. Of course, some people were better able to build up savings or to see their debts honoured. Today, financial products have become both more necessary and more complex. And yet, the situation for lower income groups and migrants is similar – they are no more likely to be financially included than their ancient counterparts. In modern societies, however, the importance of financial products and services means that people who cannot access them are also excluded from participating fully in economic and social institutions.

The cost of financial exclusion

Financial exclusion is here defined as poor access to affordable financial products and services, most notably banking, savings, credit, insurance and advice. This exclusion affects many aspects of an individual’s life. For example, people who don’t have a bank account might have difficulty accessing basic services such as heating, water and other utilities. Workers who are paid in cash are vulnerable to unscrupulous employers and to criminals who target these “walking ATMs.” Further, the “unbanked” might be forced to rely on other parties – such as “payday” or predatory lenders that charge extortionate rates to cash cheques and provide other day-to-day financial services. Building credit ratings and savings become essentially unattainable goals.

Two possible reasons explain financial exclusion. First, some groups are either more risky or less profitable for financial institutions; in other words, institutions believe it is more “costly” to design products for these people. Second, existing financial institutions are unable or unwilling to design new products and services for groups that don’t fit into their existing practices.

This, then, suggests two strategies for responding to financial exclusion. The first is to accept or slightly adapt existing practices; the second is to design new institutions or ways of doing things so that everyone is financially included.

Towards financial inclusion

Real world interventions to ensure migrants are financially included now typically adopt both perspectives: working with existing institutions and practices and reforming them to include migrants, and at the same time developing new policies and practices. At the policy level, strategies include improving employment opportunities by adopting wide ranging or targeted education, and labour market policies that address for example, equality, discrimination or precarious work. Other interventions include ensuring access to affordable housing and healthcare.

In terms of practice, a common way of adapting is to provide financial education or financial literacy through which participants better understand ideas and concepts such as interest rates, insurance, mortgages and basic accounting. This is particularly common in development contexts, and for people who may have less experience of financial institutions and practices. Successful practices, such as microloans, are being adopted from these contexts and used in developed nations.

Basic Banking – Three examples of financial education are Durham’s Latino Community Credit Union, Offenbach’s Fit for Finance, and Capital Area Asset Builders (CAAB) in Washington, D.C. In each of these cases, the financial institution or intermediary organization provides further education and literacy on financial issues, with the expectation that more informed consumers will take up more affordable financial products, be less likely to get into debt, and be better able to plan for the future.

Significantly, in each case migrants are provided more than information on how to navigate finance: in Durham, local residents can open a bank account in a credit union without immigration documents; in Offenbach, Germany, migrant participants (mainly Turkish and Russian) could meet with a mentor for financial advice; and in Washington, D.C., CAAB offers a matched savings scheme as well as money management and financial coaching services.

Other good practices focus on existing products, and particularly on basic banking (see Scotiabank’s StartRight Program, Bank On San Francisco, and the U.K.’s basic bank account). Access to banking may be likened to a utility or even a “right” given the need for a transactional account to participate in any kind of economic activity. And because migrants may not have the official identity documents demanded by many banks, practices that focus on access to banking can have a great impact.

Matched savings – Individual development accounts (IDAs) and microfinance are arguably the two most prominent alternative products to improve financial inclusion. Matched savings deviate from mainstream savings products by offering a “match” for each dollar saved (say 1:1 or 4:1) rather than an interest rate. This idea was first promoted by Michael Sherraden (in Assets and the Poor, 1991) and piloted in the “American Dream Demonstration” in 1997 to enable “low-wealth families to save and enter the financial mainstream…build assets and reach life goals.… These savings can be used to buy a home, pay for post-secondary education, or start a small business.”

Internationally, such matched savings schemes have been adopted in countries including the U.S. (see the CAAB), Uganda, China, Israel, Japan, Singapore, Kenya, Hungary and the United Kingdom. Typically, such schemes do not focus exclusively on immigrants, though some U.S. programs focus on groups experiencing significant wealth and savings gaps: Native Americans (see Washington University Native Assets project), Latinos and African Americans (see Closing the Racial Wealth Gap; also New America Foundation).

Home ownership – One of the major aims of IDAs is to build up savings for a deposit for home ownership. Those who build up savings, seek home ownership, and invest in their children through education and other skills are thereby choosing to settle in their country of residence; for migrants, savings and wealth accumulation may be viewed as an indicator of successful economic integration.

An example of how policy both adapts existing practice (in this case mortgages) but also invents new ideas is the development of services since the 1990s for those Muslims who interpret the Islamic prohibition on interest as rejecting the interest rates underpinning mainstream mortgages. U.S. financial institutions have since developed a variety of services in response; for example the Chicago Reserve Bank offers interest-free “loans” in the form of joint-owner partnerships or by charging lease fees instead of interest.

Access to credit – Microfinance was originally piloted in developing countries as an alternative to modern forms of credit that are rarely available outside major cities. In countries including the U.K. (Fair Finance), Canada (Immigrant Access Fund) and Germany (Evers and Jung) microfinance has targeted migrants as well, who may either be excluded from mainstream sources of credit or face extortionate interest rates (often above 200% annual percentage rate (APR) in the U.K.) due to their lack of credit history. Fair Finance is a good example of the approach: the organization is locally based in a part of London with a large number of migrants, and hires a significant number of people from the local area. This local intelligence ensures that Fair Finance understands why particular clients need money, and any support they need to repay the loan or grow their business. Wherever it’s developed, microfinance is typically based on more face-to-face interactions between the microfinance institution and the debtor to ensure a lower interest rate than those calculated by statistical risk-scoring. Fair Finance founder Faisel Rahman says, “We are returning to old style banking – relationship lending – and putting humanity back in the lending process.”

The Immigrant Access Fund (IAF) in Calgary takes a similar approach to loans that aim to prepare immigrants for employment. The IAF takes a holistic view of both the borrower and “employability.” As a result, loans are used for a variety of expenses – from tuition and exam fees to transportation to general living expenses. Loans are based on trust and good character, with an eye towards the borrower’s potential. According to Dianne Fehr, executive director of the program, “We lend to people not based on where they are today, but where we believe they will be in the future.”

A broader vision of financial inclusion

We need to distinguish strategies that more or less accept or adapt existing financial institutions and practices from those that seek more wholesale reform or even new institutions and practices. Given the dominance of mainstream finance, the importance of banking for those seeking work beyond the limited opportunities in the cash economy, the need for everyone to build up savings and wealth to realize their life goals, and the wider social participatory effects of financial inclusion, practices must seek to engage mainstream institutions to do more for migrants and other disadvantaged groups.

On the other hand, if we frame these questions solely in terms of financial inclusion, we are vulnerable to existing institutions and practices declaring some customers or clients are too risky or costly to receive their services. As we have put it elsewhere “financial inclusion should be more expansively conceptualized to include economic well-being, personal autonomy and citizen participation.” (Financial Inclusion and Ethnicity, 2008)